Brad is an associate clinical professor at the University of Colorado Law School and the director of entrepreneurial initiatives at Silicon Flatirons. He has been a TechStars mentor since 2008.
Many entrepreneurs are surprised to learn that a business is already a legal entity—at least, technically—even if they did not take action to legally form the company. This is like thinking you're not going to the prom only to find out that your parents have already arranged the date.
Like a prom date arranged by your parents, the default entity for your business is probably not the one that you want to dance with, let alone get married to. The following are three key drivers to guide when and why you need to select a legal entity that fits your business.
First, limit personal exposure. Ask yourself—if something goes awry, could this business create liabilities that should be separate from me as an individual? An operating business is, by default, a sole proprietorship (if operated by one person) or a general partnership (more than one person). Here's the problem: these legal forms do not separate a business's liabilities from a person's individual liabilities.
As a result, an owner in a default entity is personally liable for the business's problems. For example, your partner signs the business up for a year-long lease. The startup fails. Guess who ...